Shedding Light on Non-Financial Risks A European Survey

Transcription

1 1

2 Shedding Light on Non-Financial Risks A European Survey This research is sponsored by CACEIS Research Chair: Risk and Regulation in the European Fund Management Industry Noël Amenc Professor of Finance, EDHEC Business School Director, EDHEC-Risk Institute Chairman, EDHEC Risk Indices & Benchmarks Samuel Sender Applied Research Manager, EDHEC Risk-Institute

3 Motivation: More regulations or better regulations? 2008 crisis (Lehman, Madoff, AIG) triggered numerous regulatory initiatives aimed at non-financial risks Simply more regulation or better regulation? Is regulation applicable? Is it useful does it answer challenges? What are the likely consequences for the European fund management industry? What do industry professionals feel is needed? Are net costs or benefits to be expected? Questions that can be answered by a survey

4 EDHEC-Risk surveys professionals on regulatory priorities The survey ran from 27 June to 18 September 2011 Responses from 163 high-level professionals and follow-up interviews 100 questions on 5 regulatory themes: i) transparency; ii) responsibility of the industry; iii) restitution; iv) distribution; and v) judicial powers of investors Split by respondents firm and country (in %) 4

5 2010 EDHEC-Risk study: Improvements needed for regulations and practices Amenc and Sender (2010) show that the increase in non-financial risks stem notably from: Growing sophistication of transactions and instruments; Enlargement of eligible assets without impact assessment; Inappropriate regulatory certification facilitating mis-selling; Lack of harmonisation of rules and supervision across countries. The study put forward the idea that ratings risk of non-financial risks would foster transparency Parties duties need to be spelled out in law or contract Judicial harmonisation also needed 5

6 Main conclusions: Transparency and responsibility as regulatory priorities Strong, shared agreement that transparency, information and governance, and the financial responsibility of the industry should be the focus of regulators Synthetic index: the table shows the percentage of respondents who picked each theme as their nth priority for new regulation. The synthetic index is computed for each theme as the sum over n of (1/n) times the percentage of people who chose that theme in the nth place. 6

7 Non-financial risks are a true concern to the industry Importance of all risks. Bankruptcy of an intermediary, collateral, internal or external fraud, liquidity, breaches of investment rules all above 75% (mis-selling risk at 70%) Protection: Respondents feel less protected against liquidity risk Reasons for the rise of non-financial risks: Increased sophistication of operations first (77%) Reduced capacity of some intermediary to guarantee the return of assets (59%), inadequate and/or unclear regulation (57%) and the absence of responsibility of management companies regarding restitution (53%) 7

8 Recent regulatory initiatives are met with uncertainty and caution AIFMD will marginally contribute to decreasing non-financial risks, whereas the UCITS automatic notification procedure will marginally increase them 8

9 Industry s top priority: Transparency, information and governance Respondents consider an important priority for regulation would thus be to improve transparency and they ready to pay the price (more than for other types of measure) An overwhelming majority of respondents (91%) agree that regulators should ensure that the information is indeed fair, clear and not misleading A very strong majority of respondents (79%) agree that fiduciary duties of asset managers should be reinforced, by stating that they must invest for the sole benefit of their clients. Ratings of non-financial risks in the KID are a good way to improve transparency (53%) 9

10 2 nd priority: Stronger responsibilities for asset managers, clearer for depositaries Asset managers should have greater responsibility regarding non-financial risks (67% agree) But the burden should not be limited to them: greater fiduciary duties should be required of depositaries (65%) A clearer responsibility regime should be instated for depositaries, with monitoring and obligation of means (75% agree). Mixed view on risk-based capital requirements (based on ratings of non-financial risks) for asset managers 44% agree as respondents are unsure how these would apply Capital requirements viewed as costly Reinforcing and homogenising fiduciary duties as a less costly enforcement of responsibilities? 10

11 Restitution: Responsibilities should be clarified ex-ante Respondents are primarily in favour of a clarification of the perimeter of responsibilities A strong majority of respondents (69%) agree that depositaries should be responsible for the unconditional restitution of assets under their custody or control The restitution of assets should be contractually defined between depositaries and asset managers at the creation of the fund (68%) This is in line with proposals and responses to ESMA consultation (responsibilities differ across asset classes) No clear role for insurance (ICSD, private insurance) 11

12 Distribution: Clarifications are needed A very strong majority of respondents (81%) agree that responsibilities should be clarified ex-ante according to who controls each subset of information. A majority of respondents (69%) agree that distributors should have complete responsibility as the first line of defence for investors, but it could fall back on other parties if they have provided inappropriate or misleading information So, distributors have a major role to play, not only to be transparent themselves but also to request transparency from their providers, in line with Amenc and Sender (2010) 12

13 Judicial powers: Agreement on the need for class actions A majority of respondents (70%) agree that investors should be able to launch class action suits to get fair compensation Not for penalties (37% agree with penalties; 36% disagree) This echoes the criticism of class actions that it forces deep pockets into settlements of baseless claims As traditional administrative protection is deemed insufficient, judicial powers are credible means of protection Those class actions would have to be defined within a European framework to be consistent across countries European ombudsman/mediator should be created (52% agree; 20% disagree) to settle cross-border cases 13

14 Greater protections expected to be a net cost to all parties A net cost to all parties Greater protection on aggregate would be a net cost or a high net cost to asset managers (70% of our respondents), to depositaries (69%), and to custodians (73%) Costs of greater protection regarding regulation on distribution would mostly be borne by asset managers On the other hand, costs of stricter obligations of restitution would fall mostly on depositaries and custodians Respondents are ready to pay for greater transparency more than for any other measure 14

15 In general, scepticism still surrounds regulation Non-financial risks are inherent to investing and, even when not rewarded, they must be taken The existing complexity and internationalisation of UCITS funds may make it impossible to guarantee the restitution of assets at a reasonable cost (59%) We currently face a risk of unconditional restitution of restitution in all UCITS funds Secure UCITS for which the depositary is contractually or legally unconditionally responsible for returning all assets that can be returned is worth investigating (67%)

16 Political risks: Will conclusions be heard? Preferred regulatory options firstly transparency and secondly manager s responsibility, more so than administrative protection are very robust across geographies and types of firms (asset managers, institutional investors) This echoes responses to ESMA consultation Yet political risk that key messages are ignored Risk that no objective reason to discharge depositary liability of restitution in UCITS This would reduce possible diversification and increase markedly costs

17 Open Discussion Noël Amenc, Director, EDHEC-Risk Institute Jean-Marc Eyssautier, Chief Risk and Compliance Officer, CACEIS Samuel Sender, Applied Research Manager, EDHEC-Risk Institute

18 Importance of non-financial risks How important to you are the following non financial risks? Bankruptcy of a financial inter mediary (broker, sub custodian, etc.) Collateral risk (no restitution of collateralised assets) Liquidity risk (freezing of shares or units) Fraud (internal or external) Mispricing, misevaluation, or bad accounting Irrelevant Slightly important Important Very important Mis selling (inappropriate information or inadequate product/advice) Breach of investment rules

19 Perceived protection from nonfinancial risks How protected from the following non financial risks do you feel you are? Bankruptcy of a financial inter mediary (broker, sub custodian, etc.) Collateral risk (no restitution of collateralised assets) Liquidity risk (freezing of shares or units) Fraud (internal or external) Mispricing, misevaluation, or bad accounting Not at all Poorly Rather well Very well Completely Mis selling (inappropriate information or inadequate product/advice) Breach of investment rules

20 Rise in non-financial risks How important were the following factors in the recent rise in prominence of non financial risks? Increased sophistication of oper ations Lack of professionalism or poor training of some intermediaries Inadequate and/or unclear regulation (especially related to non financial risks) Reduced capacity of some inter mediary to guarantee deposits Absence of responsibility of management companies regarding restitution Irrelevant Slightly important Important Very important Lack of harmonisation of rules Internationalisation of the fund management industry

21 Transparency, information and governance How much do you agree with the following assertions regarding regulations on transparency, information and governance for non financial risks? Regulators should enforce better governance through an increased role for independent administrators. Regulators should enforce better governance through reinforced responsibilities for auditors. Regulators should enforce better governance through greater fiduciar y duties of administrators. Regulators should reinforce governance by appropriate code of conduct of fund managers (such as the EFAMA code for external governance). Fiduciary duties of asset managers should be reinforced by stating that they must invest for the sole benefit of their clients. Strongly disagree Disagree Unsure Agree Strongly agree Regulators should ensure that the inf ormation is indeed fair, clear and not misleading. Legal penalties should be put in place for rating agencies. Quantification of non financial r isks (e.g. ratings) should appear in the Key Information Document

22 Financial responsibilities of the industry How much do you agree with the following assertions regarding regulations on capital protection and financial responsibility for non financial risks? Greater fiduciary duties should be required of depositaries. A clearer responsibility regime should be instated for depositaries, with monitoring and obligation of means. Asset managers should have greater responsibility regarding non financial risks. A European regime of retail investor insurance (ICSD) should be created. The availability of private insurance against non financial r isks should be required. Strongly disagree Disagree Unsure Agree Strongly agree Capital requirements should be increased for all intermediaries. Risk based capital requirements (based on ratings of non financial r isks) should be applied to asset managers

23 Restitution How much do you agree with the following assertions regarding regulations on the restitution of assets? The restitution of assets to investors should be unconditional. Depositaries should be responsible for the unconditional restitution of all assets. Depositaries should be responsible for the unconditional restitution of assets under their custody or control. The restitution on assets should be contractually defined between depositaries and asset managers at the creation of the fund. The restitution on assets should be contractually defined between depositaries, sub custodians and asset managers. This contractual definition should be declared in the Key Information Document. Only if an entity fails to perform its obligations should that entity take full responsibility for the assets, so if it performs it should not take responsibility. Restitution of UCITS assets should be made in reasonable delays. Strongly disagree Disagree Unsure Agree Strongly agree Restitution of UCITS assets should be immediate

24 Distribution How much do you agree with the following descriptions of responsibilities for distribution? Distributors should have complete responsibility as the first line of defence for investors, but it could fall back on other par ties if they have provided inappropriate or misleading information. Responsibilities should be clar ified ex ante according to who controls each subset of information. Depositaries should have a strong responsibility of control of all marketing information. Asset management firms have a central role in the delivery of information, so they should have the central responsibility in the distribution for their products. Strongly disagree Disagree Unsure Agree Strongly agree Fund sponsors should have the central responsibility for their products

25 Judicial powers of investors How much do you agree with the following regulations on the judicial power of investors regarding non financial risks? Investors should be able to launch class action suits to get fair compensation. Investors should be able to launch class action suits to get fair compensation and additional penalties. Because of diverging national laws, class action suits in Europe only mak e sense if they are brought to a pan European authority or court. A European savings protection authority (rather than just a savings regulation authority) should be created. Strongly disagree Disagree Unsure Agree Strongly agree An ombudsman/mediator for the European Securities and Markets Authority should be created

26 Rules in AIF/PE and UCITS funds should be aligned How important is it that the rules be aligned in AIF/PE funds and in UCITS funds? Depositary's fiduciary duties Depositary's obligations of due diligence Depositary's obligation of restitution Asset manager's fiduciar y duties Asset manager's due diligence ob ligations Asset manager's responsibilities for non financial risks Irrelevant Slightly important Important Very important Distributors Promoters

27 Costs for asset managers Would greater protection be a net cost to asset managers? Transparency, information and governance Financial responsibility of the industr y Regulation on distribution Stricter obligations of restitution High net cost Net cost Neutral Net benefit High net benefit On aggregate

28 Costs for depositaries Would greater protection be a net cost to depositaries? Transparency, information and governance Financial responsibility of the industr y Regulation on distribution Stricter obligations of restitution High net cost Net cost Neutral Net benefit High net benefit On aggregate

29 Willingness to pay and charge for regulation How much are you willing to pay for greater protection? Transparency, information and governance Financial responsibility of the industr y Regulation on distribution Stricter obligations of restitution How much are you willing to charge for greater protection? Transparency, information and governance Financial responsibility of the industr y Regulation on distribution Stricter obligations of restitution

30 Views on regulation The role of regulations is to limit non financial risks and ensure that they are controlled and managed, not to suppress them. Insuring risks will lead to a de responsibilisation of investors. How much do you agree with the following statements? A depositary cannot guarantee the restitution of assets that are not under its custody and control. Regulations cannot guarantee the restitution of assets at a reasonable cost. The fund management industr y cannot guarantee the restitution of assets at a reasonable cost. The greater regulatory constraints drastically limit the innovation in financial markets. Strongly disagree Disagree Unsure Agree Strongly agree

31 Views on secure UCITS How much do you agree with the following statements? Secure UCITS are the best way to clarify responsibilities between parties in the fund industry. They are the best way to allow clear cut information of non financial risks in funds. They would create a subset of UCITS which would confuse the definition of UCITS funds and thus be detr imental to the UCITS brand. They are inapplicable given the sophistication of operations even in traditional assets. Strongly disagree Disagree Unsure Agree Strongly agree They will generate large opportunity costs for investors as they will de facto restrict the investment universe